The present invention relates to structural incentives, activity incentives and economic incentives for participants in a centralized trading market.
Externalities occur when one person's actions affect another person's well-being and the relevant costs and benefits are not reflected in market prices. Externalities can be positive, providing benefits, or negative, providing harms.
Automation of a financial market has historically been difficult when the financial instruments are highly illiquid or have naturally imbalanced supply and demand. Thus, these markets remain dependent on person-to-person trading, usually conducted via the telephone or instant messaging. Market participants are resistant to losing the benefits of person-to-person trading relationships.
When transitioning from a market premised on participants' knowledge of each other, to an automated market where participants participate anonymously, the behavior incentives due to personal relationships are no longer available. Accordingly, to operate effectively, automated incentives should take the place of the incentives implicit in the personal relationships.
In newly automated markets, there is a need for automated incentives to promote good behavior and discourage bad behavior.